The end of innocence

The success story of corporate India today largely began, in the India that was Bharat, when enterprising families scaled their businesses upward, in the first flush of independence and were later on stimulated with the elixir of liberalisation. On this journey one of the most pivotal figures on the horizon was the ‘auditor-Saab’. Like the trusted family doctor, the auditor acted as consultant, tax advisor, investment strategist, internal auditor and sometimes as an accountant!

The integrity of the roles or independence were never either questioned, or compromised. But time and business since then have changed to a great extent. Demand for specialists and sophisticated skills have heightened a lot. Market requirements of assurance, independence and stakeholder’s ability to seek recourse have totally changed this picture of discourse today.

Though India remains one of the few major economies of the world, where litigation against an auditor is virtually unheard of, the signs are on the wall. The Companies Bill, introduced in Parliament in 2008-end and the market events in the opening hours of 2009, have perhaps signaled the turning point in audtors roles, responsibilities and liabilities.

If the proposed Companies law has its way, then the auditor or his relatives, including brothers and sisters and lineal ascendants and descendants, cannot hold any security in any company in the group where even a single company is being audited by the auditor. Regulators have seem to have overlooked the practical aspect of audit firms keeping a track of the extended families of each of their partners and their shareholding and the government ensuring compliance with this requirement. Also, there is always the soap opera possibility, of an estranged brother buying shares in group companies to spite his auditor sibling!

While powers, duties and prohibited services, of an auditor have been listed in the proposed Act, some of the expectations from an auditor are much more open-ended than any comparable legislation. For example, an auditor’s report must contain any qualification, reservation or adverse remark relating to “maintenance of accounts and other matters connected therewith”.

Given the regulators penchant for taking a very low threshold view of materiality is fraught with the risk of inconsistent interpretation and raising expectations from an audit well beyond the threshold of an auditor’s capacity to deliver, within a normative audit framework. Prohibited services include generic descriptors like “investment advisory services”, “management advisory services”, etc. It is desirable that an auditor should be prohibited from acting as broker dealer, promoter or underwriter on behalf of an audit client, or “act in the capacity of management”.

But there are many things that an auditor traditionally does, like advising and scoping due diligence processes, providing advisory services for market analysis, provide guidance of existing regulatory and listing rules, identifying attributes for a potential strategic partner etc, which may all be captured under the proposed definition of prohibited services. This will not only make it extremely difficult and costly for companies, to secure such advisors, but also has the potential of raising an entry barrier to the audit profession, particularly for young bright professionals.

The main concern is that contravention relating to the clauses pertaining to auditors’ reporting responsibility, prohibited services, etc. would lead to the quadruple whammy of imprisonment of the auditor; a fine extending upto Rs 25 lakhs; entail refund of the total revenue received by him; and make him liable to pay damages not only to the company but to any other affected person. The last one particularly, seeks to expand the auditors “duty of care” beyond the recipients of the audit report, to literally the whole world.

How many audit firms would be able to annually pay the premium or willing to carry the huge risk that these requirements entail? Also, recent demands for mandatory joint audit and rotation would increase audit risk since it would decrease auditors’ familiarity with his client and his coverage area. A decade ago, 50 per cent of new professionals joined auditing profession every year. Today, according ICAI figures, more than 90 per cent are opting to join industry.

The question is, are audits about to get much costlier for companies? Will market expectations force introduction of forensic audits? Will peer reviews become wide spread and as onerous as an audit? Are the days of innocence truly over?

This article appeared in the 19 January 2009 edition of Business Standard, which is available at this link.